What is a Partnership?
A partnership is a business entity formed by two or more people who operate a business for profit as co-owners. For the purposes of creating a partnership, a “person” is any entity with its own legal status, including not only a human being but a corporation, trust, government entity, or another partnership. There are a variety of possible Partnerships are governed by the law of the state in which they are associated. Partnerships can take several forms including: general partnerships, limited partnerships, limited liability partnerships, and occasionally single member partnerships. Each of these is subject to its own unique set of rules and restrictions. The remainder of this article deals primarily with general partnerships, though many of the principles are the same for other forms of partnership.
How to Create a Partnership
The law deems a partnership to be formed whenever two or more people do business as co-owners for profit. Whenever two or more people share profits from a business as something other than payment for a debt or goods or services rendered, states presume a partnership is formed. When a partnership is created without legal formalities, state law provides a set of default rules which govern the partnership.
Although no formal agreement is required, partners generally enter into a “partnership agreement” which details the rules governing the partnership.
Consequences of Operating as a Partnership
Tax Consequences
For federal income tax purposes, partnerships are considered “flow through” entities meaning partnership profits are not subject to double taxation. Each partner pays taxes on their share of the entities taxable income. Partnerships are required to fill out IRS Form 1065 which details the partnerships taxable income. Partners declare their portion of this taxable income by filing IRS Form 1040 and completing schedule E. It is worth noting partners must pay their share of taxable income regardless of whether the income is actually distributed to the partners.
Liability Consequences
General Partnerships have unlimited liability. Partners are personally liable for the debts of the partnership. A partnership relationship creates an agency relationship between all of the partners and the partnership, meaning absent a contrary provision in a partnership agreement, any partner can enter into obligations on behalf of the partnership. Furthermore, each partner is liable for the torts of both the partnership and the other partners. Because of this liability, many partnership prefer to operate as limited partnerships or limited liability partnerships.
Other Consequences
Partnerships are considered a legal entity distinct from the owners of the partnership, meaning the partnership can hold land in its own name, file lawsuits, and be sued. Although a partner may transfer their share of distributions, profits, and losses from the partnership, partners are prohibited from assigning their other rights in the partnership, which is to say although you can transfer your financial interest in a partnership, you cannot transfer your status as a partner without the consent of your partners.
Advantages of Operating as a Partnership
The major advantages of a partnership are:
- Flow Through taxation
- Extremely flexible structure
- Limited Formalities
- Status as an independent legal entity
- Ability to have more than one owner
Disadvantages of Operating as a Partnership
The disadvantages of a partnership are:
- Unlimited liability for the debts of the partnership
- Liability for the debts partners incur in the course of the partnership
- Limited duration (terminate on death or resignation of a partner)
Legal Disclaimer
This website provides information addressing legal topics of interest to the general reader. You should not consider this information designed or adequate to meet any of your particular legal needs, concerns or inquiries. You should consult with a lawyer licensed to practice law in the jurisdiction appropriate to your legal situation to assess your situation and provide you with appropriate legal advice.